Steven L. Schwarcz* Sovereign Debt Restructuring: A Model-Law Approach

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1 JGD 2016; aop Steven L. Schwarcz* Sovereign Debt Restructuring: A Model-Law Approach DOI /jgd Abstract: Unlike individuals and corporations, countries indebted beyond their ability to pay cannot use bankruptcy laws to restructure unsustainable debt. The United Nations and the International Monetary Fund have attempted to propose treaties to enable that debt restructuring, but the political difficulties of reaching a worldwide consensus have stymied their efforts. This article argues that a modellaw approach to restructuring unsustainable sovereign debt should be feasible and effective because the vast majority of sovereign debt contracts are governed by the laws of either the debtor-state or two other jurisdictions. Those jurisdictions individually could enact a model law to give struggling nations a real prospect of equitably restructuring their debt to sustainable levels. By enabling such debt restructuring, that enactment would also help to foster the norms required to facilitate the development of international treaties. 1 Introduction Recent court decisions in the UK regarding the illegality of exit consents 1 and in the US regarding pari passu clauses in Argentine sovereign debt, 2 as well as 1 The Chancery Division of the English High Court held, in the Anglo Irish case Assénagon Asset Management S.A. v. Irish Bank Resolution Corporation Limited (formerly Anglo Irish Bank Corporation Limited) [2012] EWHC 2090 (Ch), that exit consents are illegal, casting doubt on the effectiveness of exit consents to restructure debt under English law. See, e.g. Patrick S. Kenadjian, The Aggregation Clause in Euro Area Government Securities, in Collective Action Clauses and the Restructuring of Sovereign Debt 143 (Patrick S. Kenadjian, Klaus-Albert Bauer and Andreas Cahn, eds. 2013) (observing that the judge in the Anglo Irish case held that it was not lawful for the majority to aid in the coercion of a minority by voting for a resolution which expropriates the majority s rights for nominal consideration[,] thus cast[ing] doubt on the legality under English law of any form of exit consent that imposes less favorable conditions on those who refuse to participate in the associated exchange offer. ). Although exit consents have been severely criticized in the US, they have survived judicial challenges made by minority bondholders. See Katz v. Oak Indus. Inc., 508 A.2d 873 (Del. Ch. 1986). 2 NML Capital, Ltd. v. Republic of Argentina, No. 08 CV 6978 TPG, 2012 WL (S.D.N.Y. Nov. 21, 2012) (holding that the pari passu clause in Argentina s defaulted bonds contract *Corresponding author: Steven L. Schwarcz, The Stanley A. Star Professor of Law and Business, Duke University School of Law, P.O. Box 90360, Durham, NC , USA, schwarcz@ law.duke.edu; and The Centre for International Governance Innovation (CIGI), Waterloo, Canada

2 2 Steven L. Schwarcz the ongoing Greek debt crisis, have dramatically highlighted the risks of an inadequate legal resolution framework for restructuring unsustainable sovereign debt. 3 Even those who are not adherents of sovereign bankruptcy believe that the status quo contractual approach is deeply dysfunctional and produces bad law. 4 Unresolved sovereign debt problems are hurting individual debtor nations and their citizens, as well as their creditors. 5 A sovereign debt default can also pose a serious systemic threat to the international financial system. 6 Few dissent from these views. 7 The main impediment is that the existing contractual approach to sovereign debt restructuring the use of so-called collective actions clauses ( CAC s) prohibits Argentina, as bond issuer, from formally subordinating the bonds by issuing superior debt and prohibits Argentina, as bond payor, from paying [restructured] bonds without paying on the [holdout] Bonds ). Thus Argentina must pay all outstanding sums on its defaulted bonds simultaneously if it makes any payment on its restructured bonds. That decision was affirmed in its entirety by NML Capital, Ltd. v. Republic of Argentina, 727 F.3d 230 (2d Cir. 2013), cert. denied in Republic of Argentina v. NML Capital, Ltd., 134 S. Ct (2014). 3 For an analysis of what constitutes unsustainable sovereign debt, see text accompanying notes 90 93, infra. This article refers to a nation obligated to repay that debt as a debtor-state. 4 Anna Gelpern, A Skeptic s Case for Sovereign Bankruptcy, in A Debt Restructuring Mechanism for Sovereigns: Do We Need a Legal Procedure? 262 (Christoph Paulus, ed. 2014). 5 Cf. Joseph E. Stiglitz et al., Frameworks for Sovereign Debt Restructuring, IPD-CIGI-CGEG Policy Brief from a November 17, 2014 conference held at Columbia University, at 1 (stating that [p]oorly designed arrangements for resolving sovereign debt problems can lead to inefficiencies and inequities... Delays in restructuring can be very costly. Insufficiently deep restructuring can force the economy through multiple crises and restructuring at a high cost. ). 6 See, e.g. Jay L. Westbrook, Sovereign Debt and Exclusions from Insolvency Proceedings, in A Debt Restructuring Mechanism for Sovereigns: Do We Need a legal Procedure?, at 251 (Christoph Paulus, ed. 2014). Cf. from Eva Hüpkes, Adviser on Regulatory Policy and Cooperation at the Financial Stability Board (FSB), to the author (July 14, 2015) (observing that doubts about the ability of states to provide additional resources can make financial institutions more fragile, in particular where there are no regimes in place that provide authorities with powers and tools to resolve financial firms without use of public funds ). 7 One prominent dissenter is Hung Tran, the executive managing director of the Institute of International Finance (IIF). Tran argues that all of the ad hoc bond restructurings since the first bond exchange of modern times (Mongolia 1997) have worked reasonably well, with the exception of Argentina in the 2000s. Hung Tran, Presentation at the Peterson Institute for International Economics (April 8, 2014), available at He admits that the existing market-based approach is not perfect. However, he contends that breaking contracts should not be easy to do and that making sovereign debt restructuring less costly will inadvertently increase moral hazard by motivating nations to engage in riskier borrowing; and that, in turn, would eventually lead to more defaults which would increase the cost of sovereign debt and make the development of emerging markets more challenging. Ibid.

3 Sovereign Debt Restructuring: A Model-Law Approach 3 is insufficient to solve the holdout problem. 8 CACs are clauses in debt contracts that enable a specified supermajority, such as two-thirds or three-quarters, of the contracting parties to amend the principal amount, interest rate, maturities, and other critical repayment terms. 9 The holdout problem is a type of collective action problem in which certain creditors, such as vulture funds, refuse to agree to a reasonable debt restructuring plan that proposes to change critical terms, hoping to receive more than their fair share of a settlement. 10 For several reasons, CACs are insufficient to solve the holdout problem. Notwithstanding decades of efforts to include such clauses in sovereign debt contracts, many contracts lack them, requiring unanimity to change critical repayment terms and thus enabling any party to the contract to act as a holdout. 11 Even in sovereign debt contracts that include CACs, the supermajority requirement may be so high (e.g. three-quarters) that vulture funds are able to purchase vote-blocking positions that enable them to act as holdouts. 12 Finally, a CAC ordinarily binds only the parties to the particular contract that includes it. The parties to any given sovereign debt contract therefore could act as holdouts in 8 Westbrook, supra note 6, at 255. For a discussion of the variety of issues that cannot be solved by CACs, see Guzman, Martin and Joseph E. Stiglitz (2016). Fixing Sovereign Debt Restructuring, in Too Little, Too Late: The Quest for Resolving Sovereign Debt Crises; Chapter 1. Columbia University Press. New York. Forthcoming. 9 Steven L. Schwarcz, Sovereign Debt Restructuring: A Bankruptcy Reorganization Approach, 85 Cornell Law Review 956, 960 (2000), also available at scholarship/508/ (hereinafter Sovereign Debt Restructuring ). 10 Ibid. Economists regard this as a form of rent-seeking behavior. Kenneth M. Kletzer, Sovereign Bond Restructuring: Collective Action Clauses and Official Crisis Intervention, IMF Working Paper, at 4 (2003). 11 Steven L. Schwarcz, Sovereign Debt: The Statutory Solution, International Financial Law Review (Dec. 2014b); also available at Cf. Text accompanying note 98, infra (observing that even after years of trying to include CACs, relatively few Greek debt agreements actually contained such clauses). 12 See, e.g. John A. E. Pottow, Mitigating the Problem of Vulture Holdout: International Certification Boards for Sovereign Debt Restructurings, Law & Economics Working Papers 81 (2013), available at (vulture funds may easily be able to marshal blocking positions, especially when a sovereign has issued multiple rounds of debt ). Cf. John Muse-Fisher, Starving the Vultures: NML Capital v. Republic of Argentina and Solutions to the Problem of Distressed-Debt Funds, 102. Cal. L. Rev. 1671, 1707 (2014) (illustrating how holdouts can bid up the price of defaulted bonds in order to achieve a blocking position ); Molly Ryan, Sovereign Bankruptcy: Why Now and Why Not in the IMF, 82. Fordham L. Rev. 2473, 2502 (2014) (stating that Greek bonds governed by UK law restructured in 2012 contained a CAC, but holdout investors successfully purchased blocking minorities in individual bond series that could not be offset by pro-restructuring majorities ).

4 4 Steven L. Schwarcz a debt restructuring plan that requires all of a debtor-state s debt issues to agree to the plan. 13 To attempt to address that final reason for CAC insufficiency, the International Capital Market Association ( ICMA ) in August 2014 proposed revised and updated forms of CACs, which would aggregate voting across debt issues. 14 These forms of aggregate-voting CACs will have the same limitations as other CACs, most notably binding only creditors who are parties to agreements that include them. 15 Even if all new sovereign debt contracts were to include aggregate-voting CACs, it will be many years before existing debt contracts, which do not include them, are paid off. 16 CACs therefore been a step forward in some ways, but they are not a substitute for pursuing a more systematic legal resolution framework 17 for helping debtor-states to restructure unsustainable debt. 18 Such a framework would reduce 13 Sovereign Debt Restructuring, supra note 9, at ICMA has also proposed a new form of standard pari passu clause for sovereign debt securities, responding to concerns that existing pari passu clauses are undermining Argentina s debt-restructuring efforts. See supra note 2 and accompanying text. I later examine that proposed clause and show why this article s proposed Model Law would solve the problem. See Section 5.2, infra. 15 Cf. Stiglitz et al., supra note 5, at 2 (observing that ICMA s CAC aggregate-voting clauses are improvements over the old terms, but are not sufficient to solve a variety of problems faced in sovereign debt restructurings ). 16 See, e.g. International Monetary Fund, Strengthening the Contractual Framework to Address Collective Action Problems in Sovereign Debt Restructuring 33 (2014), available at org/external/pp/longres.aspx?id=4911 (observing that approximately 29% of all sovereign bonds outstanding, and approximately 39% of all such bonds governed by New York law, will mature after ten years ). 17 For a systematic comparison of contractual and statutory legal resolution frameworks, see Steven L. Schwarcz, Sovereign Debt Restructuring Options: An Analytical Comparison, 2 Harvard Business Law Review 95 (2012), also available at 18 This article focuses on legal resolution frameworks to help debtor-states restructure unsustainable sovereign debt. It does not focus on ex ante approaches to help nations avoid incurring unsustainable debt, such as imposing borrowing restrictions on nations. Some have argued that any statutory approach to sovereign debt restructuring should consider ex ante approaches. See, e.g. Richard Gitlin and Brett House, A Blueprint for a Sovereign Debt Forum (CIGI Paper No. 27, at 10) (March 12, 2014), available at Gitlin and House argue that the IMF should effectively impose borrowing limits by increasing its oversight of sovereign borrowing and restricting exceptional access to its resources. Ibid. at 19. Other possible ex ante approaches might include the issuance of sovereign GDP (gross domestic product) bonds under which the payment would be a function of the debtor-state s GDP, which has been proposed by the Bank of Canada and the Bank of England. (A leading bankruptcy lawyer, Donald Bernstein, observed at the March 27, 2015 Imperial College conference, however, that such an approach might be unworkable because sovereigns are not subject to GAAP and their GDP is not transparent.) Viable ex ante approaches would, of course, complement legalresolution-framework approaches for solving the problem of unsustainable sovereign debt.

5 Sovereign Debt Restructuring: A Model-Law Approach 5 the social costs of sovereign debt crises. 19 It would also reduce the need for sovereign debt bailouts, which are costly and create moral hazard, and would reduce creditor uncertainty. Furthermore, it would reduce the risk of systemic contagion from a debtor-state s default. This article argues that a model-law approach to achieving that resolution framework should be legally, politically, and economically feasible. Section 2 of the article explains the concept of a model law and its utility in cross-jurisdictional lawmaking. It also distinguishes model laws from conventions (or treaties), the other basic form of statutory approach to cross-jurisdictional lawmaking. Section 3 of the article discusses the history of statutory approaches to sovereign debt restructuring. It also describes current initiatives that follow a statutory approach, explaining why they are unlikely to be feasible at this time. Finally, it explains why a model-law approach to sovereign debt restructuring should be more feasible than those initiatives. Notably, a model-law approach would not require general acceptance for its implementation. Because most sovereign debt contracts (if not governed by the debtor-state s law) are governed by New York or English law, it would be sufficient if England and New York State and it would be valuable if merely one of those jurisdictions enact a model law. Section 4 of the article analyzes how a sovereign debt restructuring model law should be structured. To that end, it proposes a form of a model law and discusses its provisions. The discussion explains, among other things, what a model law should cover, what it should not cover, and why. Section 5 assesses the legal feasibility of a model-law approach to sovereign debt restructuring. Because the article implicitly addresses legal feasibility throughout, this Section focuses on two critical questions of first impression. Because a model law would have to operate retroactively in order to bind a debtorstate s numerous existing creditors, this Section first analyzes the validity of such retroactivity. Thereafter, this Section analyzes the ability of a model law to overcome the veto power of pari passu clauses, which have stymied the effectiveness of existing sovereign debt restructurings efforts. 20 Finally, Section 6 shows that a model-law approach to sovereign debt restructuring should be economically and political feasible, as well as more feasible than alternative statutory approaches. Unlike a convention, for example, a model-law approach would not require general acceptance for its implementation. A modellaw approach should also have cost advantages over the status quo, both to debtor-states and to their creditors. 19 Westbrook, supra note See supra note 2 and accompanying text.

6 6 Steven L. Schwarcz 2 Model Law or Convention? There are two basic forms of statutory approaches to cross-jurisdictional lawmaking 21 a model law, and a convention (or treaty). A model law is suggested legislation for national (and sometimes subnational 22 ) governments to consider enacting as domestic law in their jurisdictions. 23 Each government enacting a model law should therefore take the steps necessary to make the law effective in its jurisdiction. To facilitate cross-jurisdictional (sometimes called cross-border) legal comparability, each government enacting a model law should, ideally, enact the same legislative text. For that reason, model laws are sometimes called uniform laws. The UNCITRAL Model Law on International Commercial Arbitration 24 exemplifies in an international context, and the Uniform Commercial Code (UCC) in the US exemplifies in a subnational context, model laws that have been uniformly enacted. A convention is an agreement or compact among nations and is synonymous with a treaty. 25 Under a convention, each member state would be bound to adhere to the convention s requirements without requiring further action by its legislative body. The most obvious advantage of a convention over a model law is that conventions are binding upon contracting states and may only be modified or denounced by a treaty amendment. 26 In contrast, model laws may be amended or denounced unilaterally by a nation without violating international law. 27 This more binding 21 By cross-jurisdictional lawmaking, I mean lawmaking that is intended to apply in two or more jurisdictions, whether or not those jurisdictions are countries or subnational jurisdictions. 22 Cf. infra note 69 and accompanying text (discussing the enactment of a model law as New York law). 23 UNCITRAL, supra note See infra note 32 and accompanying text. 25 See Black s Law Dictionary 164 (4th pocket ed. 2011) (defining convention as [a]n agreement or compact, especially one among nations; a multilateral treaty ). See also FAQ UNCITRAL Texts, United Nations Commission on International Trade Law, available at org/uncitral/en/uncitral_texts_faq.html (last visited March 12, 2015) (defining a convention as an instrument that is binding under international law on States and other entities with treatymaking capacity that choose to become a party to that instrument ). 26 See, e.g. George A. Bermann, Integration Through Law: Europe and the American Federal Experience 153 (1985) (discussing the preference of European countries for conventions as opposed to model laws) (hereinafter Integration Through Law ). 27 Ibid. Cf. Charles W. Mooney, Jr., Extraterritorial Impact of Choice-of-Law Rules for Non-United States Debtors Under Revised U.C.C. Article 9 and a New Proposal for International Harmonization, in Cross-Border Security and Insolvency 202 (eds. Michael Bridge and Robert Stevens) (2001) ( arguing that the all-or-nothing nature of a convention is superior to a model law because a model law may be materially distorted by an enacting jurisdiction).

7 Sovereign Debt Restructuring: A Model-Law Approach 7 feature provides parties greater certainty that treaty-bound nations will follow through on their commitments, and not renege as political winds shift. 28 Nations sometimes see that greater certainty as a disadvantage, especially if they are experimenting with new proposals. 29 Experimentation requires flexibility, so the more relaxed nature of a model-law approach may then be more appealing. 30 For this reason, and also because the less formal process of developing and enacting a model law can promote open communication, a modellaw approach can sometimes be more productive than a more formal treaty approach. 31 Indeed, adoption of the UNCITRAL Model Law on International Commercial Arbitration, an area of law that had for many years struggled to realize reform, may have been successful, in part, due to its less formal structure as a model law Statutory Precedents This Section begins by examining the history of statutory approaches to sovereign debt restructuring. Thereafter, it describes the current initiatives that follow a statutory approach and explains why a model-law approach should be more feasible than those initiatives. 3.1 History The earliest discussion of a statutory approach to sovereign debt restructuring appears to have taken place at the 1933 Pan American Conference in Montevideo Integration Through Law, supra note 26, at Ibid. at See Ibid. See also John A. E. Pottow, Procedural Incrementalism: A Model for International Bankruptcy, 45 Va. J. Int l L. 936, (2005) (hereinafter Procedural Incrementalism ) (discussing possible explanations for the recent success of model laws). 31 Integration Through Law, supra note 26, at Jay L. Westbrook, Creating International Insolvency Law, 70 Am. Bankr. L.J. 563, (1996) (noting that it was structured as a model law because a treaty would be a greater accomplishment, but much more difficult ); Procedural Incrementalism, supra note 30 (suggesting that the model law structure is a possible explanation for the sudden and surprising reform in the area of multinational bankruptcy). 33 See Eric Helleiner, The Mystery of the Missing Sovereign Debt Restructuring Mechanism, 27 Contributions to Political Economy 91, 92 (2008).

8 8 Steven L. Schwarcz Such an approach was also proposed, in 1942, in the initial US draft for the charter of the International Monetary Fund ( IMF ). 34 That draft prohibited IMF member nations from defaulting without the approval of the Fund. 35 It also empowered the IMF to engage in compulsory arbitration of sovereign debt settlements. 36 The rationale for this strong IMF control was that objective decisions on defaults [cannot] be made by the defaulting country or by the country gaining most by continued servicing of a debt. Consideration of the pros and cons of a contemplated default by the fund would seem to promise objectivity because the IMF represents the interests of a wide range of member nations. 37 The first recent call for a statutory approach to sovereign debt restructuring came from Jeffrey Sachs, then an economist at Harvard (and now at Columbia). In an unpublished paper, he argued that although almost all sovereign debt restructuring involves the IMF, there is a lack of standards vis-à-vis the IMF s role as an international lender of last resort. 38 As a result, [t]he structure of IMF-led debt restructurings has been woefully inadequate, especially when compared to corporate bankruptcy debt restructurings. 39 I and others then followed Jeffrey s challenge. In 2000, for example, I published the first comprehensive analysis of what such a statutory mechanism should look like. 40 I attempted to offer a legal theory of sovereign debt restructuring by examining how the conceptual basis of bankruptcy reorganization law could be adapted to sovereign debt restructuring. 41 I began that analysis by analyzing which axioms should apply to sovereign debt restructuring. 42 I then applied those axioms to derive a normative framework for regulation. 43 Thereafter, I proposed a simple set of rules for an international convention which included, most notably, supermajority aggregate voting and priority claims for financiers 34 Ibid. 35 J. Keith Horsefield, The White Plan, in III The International Monetary Fund : Twenty Years of International Monetary Cooperation 95 (1969). 36 Ibid. at Ibid. That early view of IMF objectivity contrasts with today s more widespread view of IMF partiality. See infra notes 83 and and accompanying text. 38 Jeffrey Sachs, Do We Need an International Lender of Last Resort?, Frank D. Graham Lecture at Princeton University (1995). 39 Ibid. 40 Sovereign Debt Restructuring, supra note 9, at Ibid. at Ibid. at I ultimately identified the following axioms as applicable to any sovereign debt restructuring framework: it should foster, or at least not impair, the debtor-state s ultimate economic rehabilitation; it should minimally affect non-bankruptcy incentives; and it should require only minimal adjudicatory discretion in its administration. Ibid. at Ibid. at 1031.

9 Sovereign Debt Restructuring: A Model-Law Approach 9 of a sovereign debt restructuring. 44 Others followed this analysis with similar and contrasting proposals. 45 Inspired and based in part on these proposals, 46 the IMF proposed its statutory Sovereign Debt Restructuring Mechanism ( SDRM ) in Initially, the U.S. Department of the Treasury, under Secretary Paul O Neill, supported the SDRM. 48 But when O Neill (involuntarily) resigned in 2002, the Treasury Department shifted its position, apparently at the urging of Wall Street. 49 Certain emerging market countries, including Turkey, Mexico and Brazil, 50 also opposed the SDRM, concerned that it would raise interest rates on their sovereign bonds. 51 Faced with this opposition, the SDRM was deferred in favor of a CAC approach Ibid. 45 See, e.g. Patrick Bolton, Toward a Statutory Approach to Sovereign Debt Restructuring: Lesson from Corporate Bankruptcy Practice Around the World, 50 IMF Staff Papers 41 (2003), available at (arguing that elements of current corporate bankruptcy codes and practices, including an automatic stay on debt collection, should be present in a newly adopted sovereign restructuring procedure); Hal S. Scott, A Bankruptcy Procedure for Sovereign Debtors? 37 Ind. L. 103 (2003) (arguing that CACs should be abandoned in favor of a more creditor friendly SDRM); Patrick Bolton and David A. Skeel, Jr., Inside the Black Box: How Should a Sovereign Bankruptcy Framework Be Structured? 53 Emory L. J. 763 (2004) (arguing for the adoption of an SDRM-like sovereign bankruptcy framework, but with, inter alia, a strict first-in-time priority scheme and adherence to absolute priority in the classification and voting process). 46 See, e.g. Kenneth Rogoff and Jeromin Zettelmeyer, Bankruptcy Procedures for Sovereigns: A History of Ideas, , 49 IMF Staff Papers 470, , available at External/Pubs/FT/staffp/2002/03/pdf/rogoff.pdf. 47 International Monetary Fund, Proposed Features of a Sovereign Debt Restructuring Mechanism, SM/03/67 (Feb. 13, 2003). The SDRM was the brainchild of IMF Deputy Managing Director Anne Krueger. 48 Brad Setser, IPD Task Force on Sovereign Debt brief, The Political Economy of the SDRM 1 2 (Jan. 3, 2008), available at Debt_SDRM.pdf. 49 Cf. Sean Hagan, Designing a Legal Framework to Restructure Sovereign Debt, 36 Geo. J. Int l L. 299, (2005) (arguing that the opposition to SDRM by major financial industry associations was a critical factor behind the US reversal in position). 50 Setser, supra note 48, at Ibid. at Many believe that the SDRM, as proposed by the IMF, was flawed. See, e.g. Christoph G. Paulus, A Statutory Procedure for Restructuring Debts of Sovereign States, 6 Recht der Internationalen Wirtschaft 401, 402 (2003) (arguing that the SDRM had perception problems and was self-serving); Westbrook, supra note 6, at 256 (arguing against the SDRM s designation of the IMF as the supervisory entity).

10 10 Steven L. Schwarcz 3.2 Current Initiatives Nonetheless, scholars have been continuing to advocate a statutory mechanism for sovereign debt restructuring, emphasizing the limitations of the contractual approach. One such mechanism, proposed by Christoph Paulus and Ignacio Tirado, suggests the advent of resolvency proceedings. 53 Resolvency courts, similar to the Sovereign Debt Tribunals advanced in the SDRM, would help to facilitate creditor-debtor negotiations. 54 Debtor-states would be able to submit restructuring plans to be considered and approved (via majority or supermajority voting) by each class of creditors. 55 The proceedings would also allow for the participation of prospective lenders, to help debtor-states obtain financing during the debt restructuring process. 56 I also have argued that contractual approaches alone cannot solve the central problems in sovereign debt restructuring, 57 and have proposed a model international convention that has similarities to the SDRM but differs in certain important details. 58 In 2014, the United Nations General Assembly voted to begin work on a statutory approach, referred to as a multilateral legal framework, for sovereign debt restructuring. The resolution originally promoted by Argentina, apparently in response to the U.S. Supreme Court s decision to let stand a lower court ruling enforcing pari passu clauses in Argentine sovereign debt was introduced by Bolivia on behalf of the Group of 77 developing nations (of which Bolivia was then the chair) and China. 59 The US again, 60 and apparently the European Union 53 Christoph G. Paulus and Ignacio Tirado, Sweet and Lowdown: A Resolvency Process and the Eurozone s Crisis Management Framework Law and Economics Yearly Review 2013 II.2: The resolvency process should be coordinated, they argue, by the European Stability Mechanism (ESM). 54 Paulus and Tirado, supra note 53, at Ibid. at Ibid. at See Sovereign Debt Restructuring Options, supra note 17, at 116 (arguing that contractual approaches imperfectly address the hold-out problem and do not address the debtor-state interim funding problem). 58 Ibid. at My model international convention is largely self-administering, it does not impose a stay on litigation against the debtor-state, and claims arising thereunder are adjudicated through a simple arbitration procedure, potentially based upon the ICSID model. See Steven L. Schwarcz, Idiot s Guide to Sovereign Debt Restructuring, 53 Emory Law Journal 1189, (2004); Sovereign Debt Restructuring Options, supra note 17, at See current status here: 60 Press Release, General Assembly, Proposal for Sovereign Debt Restructuring Framework among 6 Draft Texts Approved by Second Committee, U.N. Press Release GA/EF/3417 (Dec. 5, 2014) [ Also speaking before the vote, the representative of the US was obliged to vote no on the draft resolution as there was ongoing work on the technically complex issue in such bodies as the International Monetary Fund (IMF), which were more appropriate venues ].

11 Sovereign Debt Restructuring: A Model-Law Approach 11 also, 61 opposes this approach. 62 The United Nations Conference on Trade and Development (UNCTAD) has been tasked with moving this approach forward. There is skepticism, however, whether any formal framework, such as a convention, is feasible at least in the near future without U.S. and E.U. support. 3.3 A Model-Law Initiative A model-law approach should be more feasible than a convention or treaty because it would not require general acceptance for its implementation. The prototype of a model law could be developed by nations, institutions, 63 or individuals. Nations and even subnational jurisdictions, such as New York State, 64 could individually enact a model law as their domestic law. That could help to develop consensus around ideas that are commercially sound and legally effective. 65 A model law could also be pursued in parallel as part of an overall strategy for developing a legal resolution framework for sovereign debt restructuring. 66 Notably, a model-law approach could sidestep the U.S. and E.U. opposition to a convention that is evident in the United Nations. 67 For example, to the extent not governed by the debtor-state s law, most sovereign debt contracts are governed by either New York or English law. 68 One or both of those jurisdictions in the case of New York law, a subnational jurisdiction 69 could enact legislation based on a model law. Thus, unlike the UCC, the initial goal for a sovereign-debtrestructuring model law would be enactment by just one or two jurisdictions. 61 Italy, speaking on behalf of the EU, stated that the IMF is the primary forum to discuss sovereign debt restructuring. Ibid. 62 None of the developed economy countries supported the resolution, although many abstained rather than vote no. See Recorded Vote at 37th meeting, Dec. 5, 2014, available at Such as CIGI or the III. See Article note. 64 See infra notes and accompanying text. 65 Oonagh Fitzgerald, CIGI Global Rule of Law Blog: Next steps towards a multilateral debt workout process, June 4, 2015, at Ibid. at The Statutory Solution, supra note See e.g. Philip R. Wood, Governing Law of Financial Contracts Generally, in Conflict of Laws and International Finance 12 (ed. 2007); Setser, supra note 48, at 16 (observing that [a]lmost all international bonds are now governed by New York law, English law, and to a lesser extent Japanese law ). 69 Although England is technically a subnational jurisdiction of the UK, it does not have a local legislature; English law is enacted by the U.K. Parliament. Alistair Gillespie, The English Legal System, in The English Legal System 4 (ed. 2013).

12 12 Steven L. Schwarcz Even if the US or the European Union had the power to preempt such a statute, it might refrain. Preemption by the US of such a New York statute 70 could motivate debtor-states to govern their debt contracts by English law, thereby marginalizing the importance of New York law in international finance. Similarly, preemption by the European Union of such an English statute could motivate debtor-states to govern their debt contracts by New York law, thereby marginalizing the importance of English law in international finance. 71 A related question is whether the provisions of the model law would be effective under national or subnational law. The answer, of course, depends on the nature of those provisions. In this article s proposed model law, 72 the only provision likely to raise concern would be its retroactivity, which would be valuable in restructuring the terms of existing debt contracts. 73 Legal retroactivity is respected under international law so long as it is neither discriminatory nor arbitrary The US government could preempt a sovereign-debt-restructuring model law enacted by New York State if, for example, it enacts an inconsistent federal law. Under Article VI, Clause 2, of the U.S. Constitution, federal law is the supreme law of the land. Thus, Puerto Rico s Public Corporations Debt Enforcement and Recovery Act was recently held to be preempted by 903(1) of the U.S. Bankruptcy Code, which provides that a State [which is defined for this purpose to include Puerto Rico] law prescribing a method of composition of indebtedness of [its municipalities] may not bind any creditor that does not consent to such composition.... Franklin Cal. Tax-Free Trust v. Puerto Rico, Case No , 2015 WL (1st Cir. July 6, 2015). It also is unlikely that US foreign policy law would preempt a sovereign-debt-restructuring model law enacted by New York State. In general, state power must yield to the initiative of the national government to conduct foreign affairs. Joseph B. Crace Jr., GARA-Mending the Doctrine of Foreign Affairs Preemption, 90 Cornell L. Rev. 203, 217 (2004). Nonetheless, a state regulation that affects foreign affairs but also regulates a traditional state responsibility could survive being preempted. Ibid. at 223. New York s enactment of the model law should represent an exercise of New York s police powers, a quintessential state responsibility. See infra notes and accompanying text. 71 These preemption-related arguments implicitly assume that New York and England has each enacted the model law or is likely to do so. 72 See Section 4.1, infra. 73 Cf. James S. Rogers, The Impairment of Secured Creditors Rights in Reorganization: A Study on Relationship between The Fifth Amendment and The Bankruptcy Clause, 96 Harv. L. Rev. 973, 1016 (1983) (observing that legislatures would want newly enacted bankruptcy legislation to be retroactive, in order to effectively reduce financial chaos by applying to all debts). 74 Sovereign Debt Restructuring, supra note 9, at [citing sources including 1 Oppenheim s International Law (Sir Robert Jennings and Sir Arthur Watts eds., 9th ed. 1992)]. The issue of legal risk is related to retroactivity. Legal risk refers to the risk that substantive provisions of a jurisdiction s law change after an agreement is signed incorporating that jurisdiction s law as its governing law. Legal risk is an inevitable risk in international agreements. See, e.g. Wood, supra note 68, at 15 (observing that [i]t is not possible by contract to stablise the law, e.g. that the governing law is that at the time of the contract. The fluctuating governing law must still be ascertained and will apply to this term of the contract. A change in the governing law will override. ).

13 Sovereign Debt Restructuring: A Model-Law Approach 13 Nothing under English law further restricts a law s retroactivity. 75 U.S. constitutional law could, however, restrict the retroactivity of New York law. This article nonetheless concludes that it should not restrict the retroactivity of New York law based on the model law. 76 Next consider how a model law should be structured. 4 Structuring a Model Law To analyze how a model law for sovereign debt restructuring should be structured, the Appendix sets forth a proposed form of a model law (the Model Law ). In this Section 4, I discuss the Model Law s provisions, explaining, among other things, what the Model Law should cover, what it should not cover, and why. Where it is clearer in context, certain of the Model Law s provisions are explained by footnotes inserted into the Model Law itself. Those footnotes are not necessarily intended to be part of the Model Law. 4.1 Rationale The preamble explains the reasons for the Model Law. The ultimate goals are to restore the debtor-state to debt sustainability, so as to relieve the undue economic burden on the debtor-state s citizens; to enable the debtor-state to pay its debts, thereby avoiding a default that might have systemic consequences; to reduce creditor uncertainty, which increases lending costs; and to reduce the need for costly debt bailouts, which create moral hazard. 75 Lord Rodger of Earlsferry, Foreword, in Retroactivity and the Common Law (Ben Juratowitch, ed. 2008) (observing that Parliament can change the legal significance of past events[,] specifically, Parliamentary acts can provide that something which was lawful when it was done should be treated as having been unlawful, or conversely, that what was unlawful at the time should be treated as having been lawful ). See also The Interpretation Act (allowing an Act of Parliament to come into force on a particular day if provision is made for it); Clive Sheldon QC, A Justified Retrospective, in New Law Journal 27 April 2012, available at com/uploads/files/cslegalweekspecialistcommercial.pdf (observing that where the retrospective effect is clear in the sentences of the legislation, courts in England will construe legislation as having [such] effect[.] ). These views of English law retroactivity are consistent with the view of Michael Crystal, Q.C., expressed to the author on June 15, 2015, at an International Insolvency Institute meeting in Naples. 76 See Section 5, infra.

14 14 Steven L. Schwarcz 4.2 Claims Covered Article 2(2) broadly defines the types of debt claims that the Model Law covers. Notably, its coverage is not limited to bond debt or other debt instruments traded as securities. The Model Law covers all payment claims against a debtor-state for monies borrowed or for the debtor-state s guarantee of (or other contingent obligation on) monies borrowed. Unlike the IMF s SDRM, which covered only long-term-maturity claims (of the types of claims it otherwise covered), the Model Law does not discriminate between, and thus covers both, long-term and short-term maturities. This recognizes that, increasingly, most sovereign debt bailouts have come in response to the [rollover] of short-term claims. 77 Covering this important cause of a debtor-state s inability to pay will help to facilitate necessary debt relief while also reducing short-termlender moral hazard; short-term lenders can no longer assume that their claims against a financially troubled debtor-state will be paid in full. That, in turn, will reduce rollover risk in this context, the risk that a debtor-state will be unable to borrow sufficient new funds to repay maturing short-term debt. 78 The head of the sovereign debt restructuring practice at Cleary Gottlieb Steen & Hamilton LLP has called rollover risk one of today s most critical sovereign debt problems. 79 Article 2(2) also broadly defines monies borrowed to include a wide range of financing, other than trade accounts payable arising in the ordinary course of business. The Model Law s coverage does not discriminate based on the nationality of the holders of the (otherwise) covered claims or the currency in which such claims are payable. 80 Consistent with the historical norms of most sovereign debt 77 Setser, supra note 48, at Steven L. Schwarcz, Rollover Risk: Ideating a U.S. Debt Default, 55 Boston College Law Review 1, 4 (2014a). 79 Luncheon speech of Lee C. Buchheit, March 27, 2015 Imperial College conference, See Acknowledgment. Cf. Rollover Risk, supra note 78 (discussing rollover risk as the most likely cause of a possible debt default by the US). 80 Such discrimination could be problematic, not only motivating foreign creditors to impose sanctions (usually trade-related) to punish [the] defaulting government but also being interpreted as a signal used by the government to communicate information to domestic and foreign agents about the [poor] fundamentals of the economy. Guido Sandleris, Sovereign Defaults: Information, Investment and Credit, 76 Journal of International Economics 267, 267 and 273 (2008). For example, in the Icesave dispute, Iceland s failure to assure protection for foreign creditors led to international litigation and motivated the UK to apply anti-terrorist legislation to freeze accounts of Icelandic citizens in the UK as retaliation. Jon Danielsson, The First Casualty of the Crisis: Iceland, in The First Global Financial Crisis of the 21st Century Part II (Andrew Felton and Carman Reinhart eds., 2009); Dalvinder Singh, U.K. Approach to Financial Crisis Management, 19 Transnat l L. & Contemp. Probs. 868, 879 (2011).

15 Sovereign Debt Restructuring: A Model-Law Approach 15 restructuring, however, the Model Law does not cover a debtor-state s internal operational debt claims, such as pension and retiree obligations, tax refunds, unpaid salaries to public employees, or social program payments. Normally these types of debts are paid in full in a later time Supervisory Authority The definition of Supervisory Authority in Article 2(5) of the Model Law references a neutral international organization. This is likely to be one of the Model Law s most controversial provisions. It currently is unclear what organization might qualify as truly neutral. Imperfect options might include, among other possibilities, a neutral committee of the IMF, the World Bank, or UNCITRAL, or even a court of the debtor-state. 82 There are concerns, however, that existing organizations are too political or conflicted. 83 More generally, the very issue of the need for a supervisory authority can raise confusion. Formal sovereign debt restructuring solutions, such as a convention, are often conflated with the need for formal supervisory bodies. 84 Under the Model Law, however, no formal supervisory authority is needed to exercise discretion because disputes are adjudicated through binding arbitration. 85 The main role of a Supervisory Authority under the Model Law is in fact ministerial: to fact-check information and to oversee the creditor voting process from Ignacio Tirado, Professor, Universidad Autonoma de Madrid, and advisor to the World Bank, to the author (March 23, 2014). 82 Professor Mooney proposes, in a different context, that a court of the debtor-state could serve as a supervisory authority in a sovereign debt restructuring. Charles W. Mooney, Jr., A Framework for a Formal Sovereign Debt Restructuring Mechanism: The KISS Principle (Keep it Simple, Stupid) and Other Guiding Principles, 37 Mich. J. Int l L. (forthcoming 2016). The Supervisory Authority might also consist of a rotating panel of III or CIGI members whose fees and expenses would be paid for by the debtor-state invoking application of the Model Law. 83 Prof. Westbrook argues, for example, that one of the SDRM s flaws is that the IMF, the supervisor thereunder, would be conflicted, having responsibility for both funding and administering the proceeding as well as addressing rights and priorities. Westbrook, supra note 6, at 256. Cf. Joseph E. Stiglitz and Martin Guzman (2015), A Rule of Law for Sovereign Debt, available at project-syndicate.org/commentary/sovereign-debt-restructuring-by-joseph-e-stiglitz-and-martinguzman (arguing that the IMF is too closely affiliated with creditors to be neutral). 84 That might in part help to explain U.S. and E.U. opposition to U.N. efforts to reach a formal sovereign debt restructuring mechanism. See supra notes and accompanying text. 85 Model Law Article 10. See also Sovereign Debt Restructuring, supra note 9, at Cf. Barry Eichengreen, Policy Proposals for Restructuring Unsustainable Sovereign Debt, in The New Public Finance 444 (2006) (arguing that a sovereign debt resolution forum need only engage in ministerial actions).

16 16 Steven L. Schwarcz Many commentators on sovereign debt restructuring have focused on supervision of the process and resolution of disputes. Professor Paulus contends, for example, that there should be a neutral supervisor that would follow procedural rules for restructuring and resolution. 87 Others advocate the creation of a permanent institutional framework for supervision 88 or argue that existing institutions may serve that purpose. 89 And yet others advocate a contractually binding arbitration process. 90 The author believes, however, that if and when an 87 Paulus, supra note 52, at Two senior fellows of CIGI have proposed, for example, the creation of a Sovereign Debt Forum (SDF), which would be an incorporated non-profit, membership-based organization that would provide an independent standing body to research and preserve institutional memory on best practices in sovereign debt restructuring. Gitlin and House, supra note 18. The concept of the SDF was borrowed and expanded from The Sovereign Debt Forum, a paper that Richard Gitlin presented in 2002 at the Council on Foreign Relations. The SDF, they argue, could also serve as a venue to facilitate early engagement among creditors, debtors, and other stakeholders when sovereign nations encounter financial trouble. Gitlin and House, supra note 18, at 6, 18. Professor Howse, in contrast, proposes a debt workout mechanism (DWM) that ensures the participation of all relevant stakeholders. Howse, Robert. Towards a Framework for Sovereign Debt Restructuring: What Can Public International Law Contribute? Forthcoming in Too Little, Too Late: The Quest of Resolving Sovereign Debt Crises, Columbia University Press, New York, See, e.g. Brooks, Skylar and Domenico Lombardi. Governing Sovereign Debt Restructuring Through Regulatory Standards. Paper presented at IPD-CIGI Conference on Sovereign Debt Restructuring at Columbia University, September 22, Forthcoming, Journal of Globalization and Development. Brooks and Lombardi argue there is a governance gap for resolving debt crises that can be filled by the Financial Stability Board (FSB), which could serve as the focal institution responsible for overseeing the coordination and further development of soft law regulatory standards for sovereign debt restructuring. 90 See generally Jubilee USA Network, Towards a Lasting Solution to Sovereign Debt Problems (2012), available at Christoph G. Paulus and Steven T. Kargman, Reforming the Process of Sovereign Debt Restructuring: A Proposal for a Sovereign Debt Tribunal, Workshop on Debt, Finance and Emerging Issues in Financing Integration (2008), available at pdf; Hugo Ruiz Diaz, The Creation of an Arbitration Tribunal on Debt: An Alternative Solution? On The Position to Take on the CADTM (2003). Paulus and Kargman have advocated a fair and transparent sovereign debt arbitration process, also known as sovereign debt tribunals ( SDT ). Paulus and Kargman, supra at 3. Under the SDT process, the decision to subject disputes to an arbitration panel would be based on contractual agreements between sovereign debtors and their creditors. Ibid. at 8. The SDT process also contemplates building trust, confidence, and legitimacy by selecting a pool of expert arbitrators who have knowledge and experience to handle sovereign debt disputes through a neutral institution. Ibid. at 5, 8. Cf. Jose Antonio Ocampo, A Brief History of Sovereign Debt Resolution, and a Proposal for a Multilateral Instrument. Forthcoming in Too Little, Too Late: The Quest to Resolve Sovereign Debt Crises, Columbia University Press, New York, 2016 (proposing an arbitration and mediation approach similar to the WTO dispute mechanisms, including independent bodies of arbitrators and mediators).